428 Part IV: Additional Considerations 
going ex-dividend on the following day. Since he must sell the stock to set up the arbi­
trage, he cannot afford to wind up the day being short any stock, for he will then have 
to pay out the dividend the following day (the ex-dividend date). Furthermore, his 
records must be accurate, so that he exercises all his long options on the day before 
the ex-dividend date. If the arbitrageur is careless and is still short some stock on the 
ex-date, he may find that the dividend he has to pay out wipes out a large portion of 
the discount profits he has established. 
CONVERSIONS AND REVERSALS 
In the introductory material on puts, it was shown that put and call prices are relat­
ed through a process known as conversion. This is an arbitrage process whereby a 
trader may sometimes be able to lock in a profit at absolutely no risk. A conversion 
consists of buying the underlying stock, and also buying a put option and selling a 
call option such that both options have the same terms. This position will have a 
locked-in profit if the total cost of the position is less than the striking price of the 
options. 
Example: The following prices exist: 
XYZ common, 55; 
XYZ January 50 call, 6½; and 
XYZ January 50 put, 1. 
The total cost of this conversion is 49½ - 55 for the stock, plus 1 for the put, less 6½ 
for the call. Since 49½ is less than the striking price of 50, there is a locked-in profit 
on this position. To see that such a profit exists, suppose the stock is somewhere 
above 50 at expiration. It makes no difference how far above 50 the stock might be; 
the result will be the same. With the stock above 50, the call will be assigned and the 
stock will be sold at a price of 50. The put will expire worthless. Thus, the profit is½ 
point, since the initial cost of the position was 49½ and it can eventually be liquidat­
ed for a price of 50 at expiration. A similar result occurs if XYZ is below 50 at expi­
ration. In this case, the trader would exercise his put to sell his stock at 50, and the 
call would expire worthless. Again, the position is liquidated for a price of 50 and, 
since it only cost 49½ to establish, the same ½-point profit can be made. No matter 
where the stock is at expiration, this position has a locked-in-profit of½ point. 
This example is rather simplistic because it does not include two very important 
factors: the possible dividend paid by the stock and the cost of carrying the position